NEAR EAST UNIVERSITY
GRADUATE SCHOOL OF SOCIAL SCIENCES
ECONOMICS MASTER’S PROGRAMME
MASTER’S THESIS
THE EFFECT OF MONETARY POLICY ON ECONOMIC GROWTH
THE CASE OF MALAYSIA FROM 1985 TO 2014
DILGASH AHMED MOHAMMED ISTOKORKI
NICOSIA
2017
NEAR EAST UNIVERSITY
GRADUATE SCHOOL OF SOCIAL SCIENCES
ECONOMICS MASTER’S PROGRAMME
MASTER’S THESIS
THE EFFECT OF MONETARY POLICY ON ECONOMIC GROWTH
THE CASE OF MALAYSIA FROM 1985 TO 2014
PREPARED BY
DILGASH AHMED MOHAMMED ISTOKORKI
20146701
SUPERVISOR
Assist. Prof. Dr. ERGIN AKALPLER
NICOSIA
2017
NEAR EAST UNIVERSITY
GRADUATE SCHOOL OF SOCIAL SCIENCES
Economics Master Program Thesis Defence
THE EFFECT OF MONETARY POLICY ON ECONOMIC GROWTH THE CASE OF MALAYSIA FROM 1985 TO 2014
We certify the thesis is satisfactory for the award of degree of Master of Economics
Prepared by
Dilgash Ahmed Mohammed Istokorki Examining Committee in charge
Assoc. Prof. Dr. Huseyin Özdeşer Near East University Department of Economics
Assist. Prof. Dr. Ergin Akalpler Near East University Department of Economics
Dr. Berna Serener Near East University Department of Economics
Approval of the Graduate School of Social Sciences Assoc. Prof. Dr. Mustafa SAĞSAN
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ACKNOWLEDGEMENTS
I thank Allah for granting me the strength to complete this work. There are many people to whom I am grateful for providing me with help and support during my research. First and foremost, I wish to acknowledge and thank my supervisor Prof. Dr. ERGIN AKALPLAR for his understanding, support, advices and motivation throughout the writing of this thesis. His assist and contribution has been so gigantic and has contributed greatly to the successful completion of this research.
I would like acknowledge WAHID KOVLI "may his soul rest in peace" and Mr. SARBAST TRWANSHI and for the efforts of all the KURDISTANS PESHMERGA and martyrs, it is a direct result of your sacrifices that I could study in peace and calmness. So with an awesome level of genuineness and quietude, I say "thank you" for all you have done and keep on doing for me, my family, my companions and our country. Yes i owe you our heroes an unimaginable obligation of appreciation. May Allah almighty reward you and your family abundantly for your sacrifices.
Above all, my unlimited thanks and heartfelt love would be dedicated to my dearest family for their loyalty and their great confidence in me. I’m greatly indebted to my father who is indeed my inspiration and the man who led me to the treasures of knowledge. I would like to thank my mom for her support, encouragement and constant love which have sustained me throughout my life.
I also want to thank Mr. RIZGAR KESTEYI, Mr. ISMAIL MUSTEFA, Dr. RAEED, my dean Dr. SAMEER F. NEEMA and Dr. MUHANNAD AL-SALA the Head of Department at Nawroz University.
There is a long list of friends that I would like to thank. I can’t mention them all but I would like to thank them from all of my heart for their valuable help and support since from the beginning of study until now.
Finally, I like to acknowledge staff of the Economics Department, Near East University, for their assist and support throughout my studies.
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DEDICATION
This thesis is dedicated to my lovely and supportive parents who have always been there for me through all my endeavors in life with challenges and words of encouragement which have been very helpful. I also wish to dedicate this to my other family members.
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ABSTRACT
This research examines the impact of monetary policy on the economic growth of Malaysia. Monetary Policy continues to be the most important policy instrument used by both government and monetary authorities in controlling economic realities especially in this era of very volatile economic realities. The ease in which monetary policy can be adjusted gives it a huge comparative advantage over fiscal policy. The choice of the Malaysian economy is predicated on its success and as a result can be a model for other developing countries seeking to achieve rapid economic growth.
As such, this research aims at analyzing the effect monetary policy has played in the rapid economic growth of Malaysia. The study utilizes secondary annual series data from 1985 to 2014 while employing the Ordinary Least Squares, Unit Root Test, to measure the nature of relationship between all variables selected.
Key Words: Monetary Policy, Economic Growth, Malaysia, Ordinary Least Squares, Unit
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ÖZ
Bu çalışma, para politikasının Malezya'nın ekonomik büyümesi üzerindeki etkisini incelemektedir. Para Politikası, özellikle çok dengesiz ekonomik gerçeklerin bu çağında ekonomik gerçeklerin kontrolünde hem devlet hem de para otoritelerinin kullandığı en önemli politika aracı olmaya devam etmektedir. Para politikasının kolayca ayarlanabilmesi, maliye politikası üzerinde büyük bir karşılaştırma avantajı sağlamaktadır. Malezya ekonomisinin seçimi başarısı üzerine kuruludur ve sonuç olarak hızlı gelişmeyi hedefleyen diğer gelişmekte olan ülkeler için bir model olabilir.
Bu nedenle, bu çalışma para politikasının Malezya'nın hızlı ekonomik büyümesinde oynadığı etkiyi analiz etmeyi amaçlamaktadır. Çalışma, seçilen tüm değişkenler arasındaki ilişkinin niteliklerini ölçmek için Olağan En Küçük Kareler, Birim Kök Testi, testini kullanırken 1985'ten 2014'e kadar olan ikinci yıllık seri verilerini kullanmaktadır.
Anahtar Kelimeler: Para Politikası, Ekonomik Büyüme, Malezya, En Küçük Kareler, Birim
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TABLE OF CONTENTS
ACKNOWLEDGEMENTS ... iv
DEDICATION ... v
ABSTRACT ... vi
ÖZ ...vii
TABLE OF CONTENTS ... viii
LIST OF FIGURES ... xi
LIST OF TABLES ...xii
LIST OF ABBREVIATIONS ... xiii
CHAPTER ONE ... 1
INTRODUCTION ... 1
1.1 . Study background: ... 1
1.2 . Statement of the Problem ... 3
1.3 . Objectives of the Study ... 4
1.4 . Research methodology ... 4
1.5 . Research Hypothesis ... 5
1.6 . Significance of the Study ... 5
1.7 . Source of Data ... 5
CHAPTER TWO ... 6
MALAYSIA ECONOMIC OVERVIEW ... 6
2.1 . Introduction ... 6
2.2 . Overview of Malaysia Economy ... 6
2.3 . Malaysia GDP and GDP Growth Pattern ... 7
2.4 . Monetary Policy in Malaysia ... 9
2.5 . Trends of Monetary Policy Instruments to GDP Growth ... 12
CHAPTER THREE... 15
LITERATURE REVIEW ... 15
3.1 . Introduction ... 15
3.2 . Conceptual Review on Monetary Policy and Economic Growth ... 15
3.2.1 Economic growth ... 17
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3.3 . Theoretical Review of literatures ... 19
3.3.1 Quantity Theory of Money (QTM) ... 20
3.3.2 Modern Monetarist Method... 21
3.3.3 Neo-Classical Growth Theory ... 22
3.3.4 Endogenous Growth Model... 23
3.4 . Empirical Reviews of Literature ... 23
3.5 . Summary of Literature Review ... 28
CHAPTER FOUR ... 30
METHODOLOGY AND ANALYTICAL FRAMEWORK ... 30
4.1 . Introduction ... 30
4.2 . Data Source and Variables Description ... 30
4.2.1 Economic Growth... 31
4.2.2 Monetary Policy Instruments ... 32
4.3 . Unit Root Test ... 34
4.3.1 Augmented Dickey Fuller Unit Root Test ... 34
4.4 . Model Specification ... 34
CHAPTER FIVE ... 36
EMPIRICAL ANALYSIS ... 36
5.1 . Unit Root Test ... 36
5.2 . Econometric Analysis ... 37
5.2.1 Residual Analysis ... 40
5.2.2 Diagnosis Test of the OLS model ... 42
5.3 . Discussion of Results ... 47
CHAPTER SIX ... 51
CONCLUSION AND POLICY IMPLICATION ... 51
6.1 . Introduction ... 51
6.2 . Main Findings of the Study ... 51
6.3 . Recommendations and Policy Implication... 52
6.4 . Limitations and Recommendations for future Research ... 53
REFERENCES ... 55
APPENDICES ... 62
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Appendix 2: OLS Results ... 73 Appendix 3: Results Diagnosis Test ... 77 Appendix 4: Data from the International Monetary Fund (IMF) ... 81
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LIST OF FIGURES
Figure 2.1: Trend of GDP (1985-2014) ... 8
Figure 2.2: Trend of Inflation to GDP Growth... 12
Figure 2.3: Trend of Interest Rate to GDP Growth ... 13
Figure 2.4: Trend of Money Supply on GDP Growth ... 14
Figure 3.1: The Transmission Mechanism of Monetary Policy ... 17
Figure 4.1: Trend of GDP growth rate ... 31
Figure 4.2: Trend of Monetary Policy Instruments ... 33
Figure 5.1: Residual Analysis ... 40
Figure 5.2: Residual Analysis (2) ... 42
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LIST OF TABLES
Table 2.1: Malaysia GDP Growth rate (2004-2014) ... 9
Table 5.1: Unit Root Tests based on Augmented Dickey Fuller ... 36
Table 5.2: Unit Root Test Based on Phillips-Perron Test ... 37
Table 5.3: Effects of the independent variables (Inflation, Interest Rate and Money supply on dependent variable GDP growth in Malaysia results ... 38
Table 5.4: Econometric Results ... 39
Table 5.5: Econometric Results (2) ... 41
Table 5.6: Normality Test Table ... 43
Table 5.7: Breusch-Godfrey Serial Correlation LM Test Table ... 43
Table 5.8: Breusch-Pagan-Godfrey Heteroskedasticity Test ... 44
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LIST OF ABBREVIATIONS
GDP Gross Domestic ProductPPP Production Power Parity IT Inflation Targeting BNM Bank Negara Malaya FDI Foreign Direct Investment IMF International Monetary Fund
OECD Organization for Economic Co-operation and Development GNP Gross National Product
MTM Monetary Transmission Mechanism GNI Gross National Income
TFP Total Factor Productivity QTM Quantity Theory of Money
ASEAN Association of Southeast Asian Nations OLS Ordinary Least Squares
VAR Vector Auto Regressive TAR Threshold Auto Regressive ARDL Autoregressive-Distributive Lag NEP New Economic Policy
OPP Outline Perspective Plan NDP New Development Plan NVP National Vision Plan
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CHAPTER ONE 1 INTRODUCTION 1.1 Study background:
The importance of government policy making and its participation in the economy cannot be over-stated. During the Great Depression, Keynes, (1930) argued that the total demand is prejudiced by many decisions of both private (domestic) and government and that there is need for government intervention and regulation of the economy. Government policy making can take two form; monetary policy and fiscal policy, Fiscal policy is the adjusting and manipulation of government spending and taxation to influence the economic outlook and position of a country (Horton, & El-Ganainy, 2009). Monetary policy is however the most important and influential economic tool of the government which it employs in the management of the economy to achieve certain desired objectives. Monetary policy manipulates the money supply and rate of interest as well as other monetary variables in order to achieve the goals and manifestation of the ruling party (Shoaib K, 2010). Most economist agree that monetary policy is best (and are) conducted by the Central Bank (or a similar institution) that is independent from the government (Mathai, 2009) although the true autonomous nature of the Central Bank from the government is one of huge debate in many countries.
Monetary policy refers to the actions undertaken by Central Bank, such as the Federal Reserve (the Central Bank of the United State) to affect and control the availability and cost of money credit with the aim to alleviate and promote national economic goals- this is the understanding of the definition given by the Federal Reserve Board. A general observation of definitions especially by Central Bank passes the notion that most Central Banks define monetary policy in terms of their aims and objectives.
The Bank of England opined that the objective of monetary policy is price-stability which implies to sustain the value of money. In other words, check inflation or the general increase in prices and services and this is accrued to the uncertainty about inflation and the need to know and if possible control future price levels which if not properly checked can be damaging to the proper functioning of the economy. Having a stable and low price level means that individual price signals can be understood more clearly, and as such more informed decisions can be made as to whether to save, lend or borrow, or the degree to invest
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and to consume, and what and when to produce. If this is in place, price stability can help bring about sustainable long term economic growth.
This clearly indicates that the Bank of England view monetary policy in the perspective of price stability by controlling or targeting inflation. Inflation Targeting (IT) as a way of defining monetary policy is also evident in the definition of the Bank of Canada which defined thus
The Canadian monetary policy aims to contribute and raise the standards (of living) for all Canadians by achieving low and stable inflation rate. To be more precise, the bank’s objective to keep the rate of inflation inside a target range jointly with the government.
Ever since the its establishment on 26 January 1959 as the Bank Negara Malaya (BNM), the Central Bank of Malaysia has carried out the traditional functions as all central banks do. The principal objectives of the BNM are to promote the economic stability of the country and maintaining a sound financial system. Its objectives are clearly defined as item (III) in the Central Bank Act of 1958 (Revised 1994)
“i. To issue currency and keep the reserve safeguarding the value of the economy ii. To act as banker and adviser to the Government
iii. To promote monetary stability and a sound financial structure and iv. To influence the credit situation to the advantage of Malaysia”
Over the years, the monetary policy in Malaysia has faced various challenges. The problematic international conditions in the late 1970s meant that monetary policy during the 1975-1984 was primarily aimed at maintaining price stability (reducing inflation) and ensuring a stable economy. The recession of 1985 in the Malaysian economy posed another big obstacle for policy makers. This made monetary policies to be eased gradually and supplementing this gradual easing of monetary policy was the depreciation of the ringgit in small steps (Shaari, 2006)
From 1987-1996 however, there was rapid domestic growth in the Malaysian economy and as a result, policy shifted in order to curtail inflationary pressures, monetary policy makers adopted tight monetary policy. Shaari, (2006) points out that this task was made even more difficult by fall in general interest of the world rate which meant interest differentials favored Malaysia and thus induced Foreign Direct Investment (FDI) making the FDI to GDP ratio to increase two folds (Ang, 2008)
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The most tasking period for monetary policy in Malaysia came towards the end of 1997-2005 when the whole region was characterized by regional financial crisis (in mid 2003) which saw extreme volatility and fluctuations in the financial markets. The central bank was faced with finding a balance between various policies in the need to address the reduction of GDP and rising inflation and also needed to ensure that the banking system and financial sector remain intact.
The recent global economic crisis of 2008-2009, also affected the Malaysian economy because of its high global economic integration (24th in the world, 2015 KOF Index of Globalization). Alp et. al (2012) points out that is this period, BNM safe guarded short term funding in the banking system and was willing to back interbank lending. It also made some intervention and the depreciation of foreign exchange rate by 150 points to 2 percent.
1.2 Statement of the Problem
There has been increased attention given to monetary policy over the past decade. Both theoretical and empirical studies have increased on this subject matter. Although economic growth is optimally achieved with a combination of fiscal and monetary policies, this seemingly one sided concentration on only monetary policy can be attribute to the fact that monetary policy is more efficient in short term adjustment because it can easily be altered to adapt to the prevailing economic realities. Modern economies are highly volatile and responsive and even unpredictable to say the least especially since globalization has made international markets and economies very much interdependent and related. Although, government can adjust the economy using fiscal policy, it involves a lot of red tape changing the tax rate and it’s spending, it involves lots of legislation as more often than not, these policies are laws of the land and there is always a due process before such can be changed. The relative ease in monetary policy decision process and its effectiveness on the economy added to the difficulty and time lag of formulating and implementing fiscal policies means that the responsibility of dealing with the present economic reality of flexibility and swiftness wholly falls on the use of monetary policy adjustments and this has contributed to the proliferation of research in this field.
Typical studies such as this however often do not go far as differentiating established economies and developing countries (Haung and Wei, 2006) and as result of this flaw, we observed that Central Banks (or the relevant monetary governing institution) are misguided and adopt inflation targeting (IT) as its main monetary policy goal. This really is a misguided
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But widely spread belief that economic policies irrespective of prevailing economic development status of countries will deliver the same result.
Generally, many developing countries are characterized by weak institutions and financial underdevelopment which ensure that the effectiveness, transmission and implication of policy differ from those of advanced countries (Ghatak and Sanhez-Fung, 2007). This invariably means that monetary policy consideration should first and foremost be based on the level of development in the economy.
It is the above premise that forms the thrust of this research
1.3 Objectives of the Study
The aim of this research is to investigate the nexus between monetary policy and economic growth in the light of developing economy with the case study being Malaysia. Primarily, the research will focus on the interactions between interest rate, inflation, money supply and growth in GDP; which will serve as the instrument for measuring economic growth. Limiting the scope of this research to this aspect is predicated on the fact that the economic effect of changes in monetary policy instrument is quite a vague subject and economic growth has various interactions with various economic indicators and policies.
Therefore, the objective is to ascertain the significant variable(s) in developing economy so as to properly identify the best monetary policy instruments that should be influenced in order to achieve the best macroeconomic goals and objective in any given economy.
In summary, the aim of this thesis is as follows:
Differentiating monetary policies and their respective effect(s) on economic growth of developing economies
Identifying the significant monetary instrument important for growth in developing countries
Based on finding, state which and what monetary policy adjustment is best suited for developed economy in order for it to maintain a constant growth path.
1.4 Research methodology
The research will apply quantitative analysis to means the relationship between GDP growth and monetary policy instrument mainly interest rate, money supply and level of inflation. Given the advancement and achievement in econometric analysis and computer software
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creation, the Least Squares Estimates analysis will be used to investigate the relationship and significance between these variables.
Due to availability of data, the scope of the analysis will be annual series data. All data used will be analyzed to make sure they are stationary so as to clarify and justify the use of our chosen econometric analysis
1.5 Research Hypothesis
H0: There is no significant relationship between monetary policy and economic growth in Malaysia
H1: There is significant relationship between monetary policy and economic growth in Malaysia
H0: There is no significant impact of monetary policy on the economic growth of Malaysia H1: There is significant impact of monetary policy on the economic growth of Malaysia
1.6 Significance of the Study
The importance of monetary policy which is the most important economic tool of the central government cannot be over-stated. A better understanding of how these policies affect is always welcome. This study is important in various ways. It will serve as an objective view of the effectiveness of monetary policy in Malaysia which is a developing country and this understanding of the Malaysia economy can help other 3rd world countries in the formulation of their own policy. The Malaysian economy has indeed improved significantly in the past 20 years. The poverty head count ratio at national poverty line dropping from 5.7 percent in 2004 to 0.6 percent in 2014, the Gross National Income per capita was $2,370 (current US$) at 1990 but has increased to $11,120 (current US$) in 2014 (World Bank stat.).
This research will serve as a source of information on various ways of adopting monetary policy and its instruments for stabilizing and spurring the economy on the path of further development while providing policy makes recommendations.
1.7 Source of Data
All data except otherwise stated will be obtained from the data bank of the World Bank. This will be gotten from the official website of the World Bank. Data from this website are drawn from international institutions such as the International Monetary Fund (IMF), the Organization for Economic Co-operation and Development (OECD).
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CHAPTER TWO
2 MALAYSIA ECONOMIC OVERVIEW 2.1 Introduction
The objective in this chapter is to present an oversight of the Malaysia economy and its monetary policies in the past years. It will also highlight the economic development trend and policies across various periods in the economy of Malaysia.
2.2 Overview of Malaysia Economy
Malaysia is an Islamic state in the South-eastern part of the continent of Asia overlooking the South China Sea from the north, an area of 329,758km and is bordered to the south, Indonesia, Thailand and the South China Sea from the north. Malaysia is an upper middle income developing country with a population of 29.90million (2014 est.) and a Gross Domestic Product (GDP) at market prices of $338.81b (current US$). It is currently 33rd in the world in terms of GDP (nominal). Its 2015 GDP at Production Power Parity (PPP) is estimated at $815.5b placing it 13th in the Asia and Pacific cumulative and 4th in the South Asia region. It is a private sector driven economy with government regulating and providing an enabling environment from proper functioning of businesses.
Before Independence from the British in 1957, Malaysia was a low-income country whose main support was on Rubber and tin production exportation. In 1947, agriculture employed more than two-thirds of the labor force in Malaysia with a further 22.5 percent in the tertiary sector, 6.5 percent in the manufacturing sector and 2.5 percent in the mining sector and this proportion remained unchanged until Independence (Yusof and Bhattasall, 2008). Business enterprises were predominantly localized and family based and on small scale. Over time though, the economy pushed towards diversification beyond agricultural and primary commodity. At Independence, Malaysia population stood at just 7.4 million.
Immediately after Independence, Malaysia moved towards diversification which has led to imperious growth in their economy since then. The post war growth of the Malaysia economy can be broadly characterized into four stages (Yusof and Bhattasall, 2008). The first phase which falls between 1957-70 is purely one of diversification as the country rigorously sorts to expand its income source from Tin and Rubber due to the volatility of their prices and the projected dwindling availability of the commodities. At this stage, also, diversification also
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pushed from primary production to secondary production. It is worthy of note that the diversification was hugely successful.
The next phase (1970-90) was defined by policies and event designed to restructuring of the economy. This phase is seen as very pivotal in the annals of the economic development of Malaysia. It was largely characterized by major economic policies which stirred the economy towards huge developmental strides such as the New Economic Policy (NEP) in 1971, the Second Malaysia Plan (1971-1975) and the Outline Perspective Plan (OPP) of 1971-1990. There was rapid increase in construction and manufacturing with strategic emphasis on equitable distribution usually through affirmative actions. FDI activities were promoted actively through introduction of Free Zone Act of 1971, the Promotion Incentive Act of 1986 etc.
The 1991-2000 growth phase is one that traversed the difficult era of the Asian Financial Crisis and period of stricter exchange rate control measures.
The recent phase 2001 to present is one of slow growth. As an export driven country, the various activities and happening in the world had adversely affected the economic growth of Malaysia in recent years; the terrorist actions of 9/11 on the United States, the Global Recession of 2008/9 as well as more increased competitive external conditions have highlighted some of Malaysia vulnerabilities and greatly impeded Malaysia growth potentials.
Khin et al. (2014) however divided Malaysia economic policy into three categories; the NEP during 1979-1990, the NDP executed from 1990-2000 and the National Vision Policy (NVP) from 2000 till present and opined that all these respectively economic policies have been hugely successful. For instance, not only was unemployment brought down during this period, the GDP of Malaysia grew from 4.276 billion USD in 1970 to 44.024 billion USD in 1990 during the implementation of NEP. Although the period of NDP was characterized by some external regional and international financial crisis, the GDP of Malaysia as at 2001 was 92.783 billion USD from the 44.024 in 1990. Another indication of success of these economic policies was the reduction of the inflation rate in Malaysia during these periods.
2.3 Malaysia GDP and GDP Growth Pattern
In the period under review, 1985 to 2014, the GDP of Malaysia has grown from 31.77 billion USD to 329.93 billion USD. The trend of GDP shown in Figure 2.1 below shows that overall,
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the GDP of Malaysia was steadily rising from 1985 till 1998 when it witnessed a dip from 100.17 billion USD the previous year to 71.77 that year. This decline in GDP is largely attributed to the 1998 Asian regional financial crisis. After that though, GDP continued to grow steadily again till 2009 when just as almost every economy in the world at that time, the GDP dropped again compared to the previous year. Ever since that time though, the GDP has consistently been increasing.
Figure 2.1: Trend of GDP (1985-2014)
Source: Computed By Researcher Using data from World Bank
0 50 100 150 200 250 300 350 1985 1990 1995 2000 2005 2010
GDP(bil USD)
9 Table 2.1: Malaysia GDP Growth rate (2004-2014)
Year GDP Growth Rate % Change
2004 6.78 2005 5.33 -27.20 2006 5.58 4.48 2007 6.30 11.42 2008 4.83 -30.43 2009 -1.52 -417 2010 7.43 120.59 2011 5.20 -42.88 2012 5.64 7.80 2013 4.73 -19.23 2014 6.03 21.56
Source: Computed by Researcher using Data from World Bank
In term of GDP growth rate however, over the last ten years’ period, the GDP growth rate has been staggering with the biggest deep observed in 2009 where the annual GDP growth rate fell from 4.83 to -1.53 which is evidentially due to the global financial crisis of 2008/09. The biggest bump in the growth rate was however observed in the following year as swift policies towards recovery really yielded the results that they were intended with the GDP growth rate of 2010 pegged at 7.43 and after the global crisis, the GDP growth rate has continued on a steady cyclical path with increases observed in 2011, increase of 7.80% change in 2012. Overall, Malaysia GDP growth indicates a very good average.
2.4 Monetary Policy in Malaysia
The evolution of monetary policies carried out by the BMN can be divided into three periods (Shaari, 2008). 1975-86 consist of the first period of monetary policy in Malaysia. In this period, the global economic environment was one characterized by major economic strains which arose from high increasing imbalances in exchange payment and high inflation. This
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resulted in economic instability in more industrialized country and a weakened US dollar. These unique challenges shaped the monetary policy formation in Malaysia in this period. Also, added to the aforementioned challenges, “second oil shock of 1979-80” and the global recession experienced in the early 1980s led to high global inflation and loose global monetary policy. The economy of Malaysia was not shielded from this inflation. Malaysian inflation was at its highest peak of 9% in this era. Faced with this challenge, the bulk of monetary policy during this time was geared at protecting the domestic economy from the external forces. The formulation of the Fourth Malaysia Plan (1981-85) signaled a major policy shift in which government and monetary authorities shielded the economy through public sector investment. This goal of this policy was to generate inward and outward domestic industrial value chains which would result to higher value added in country (Charette, 2006).
The mid 1980s came with another unique challenge for the Malaysia monetary authorities. The economy was in recession. As a response to the recession, monetary policy was eased in stages between 1984 and 1986. To their credit, policy makers continued to push towards expansion of the economy which was powered through FDI in order to create jobs and improve standard of living (Charette, 2006). In addition to these monetary policies, the local currency was depreciated against the US dollar and this provided impetus for the export market.
The next era of 1987-1996, monetary authorities were faced with a more unique problem, managing economic success (Shaari, 2008). The economy was basically operating at full capacity and it witnessed prolonged and rapid economic growth. The expansion of the economy averaged about 9.3% per year over this 9 years’ period. This astronomic economic success led to a steady rise in inflation from 0.37 to its peak of 5% in 1992. Thus, the BNM adopted a tight monetary policy stance. The task of tightened monetary policy was however made more difficult for domestic monetary policy makers due to decline in global interest rates, and in the face of rising interest rate in Malaysia, led to increased inflow of short term foreign funds causing excess liquidity in the banking sector. In reaction to this, monetary policy had to strike a balance between managing excess liquidity and the inflationary pressures that comes with it.
Monetary authorities were not successful though in reducing the influx of short term foreign currency partly due to the fact that the Malaysia currency was considered by market players
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in this ear to be well undervalued. This was however not accurate but there is the general consensus that monetary authorities did not allow the local currency (ringgit) to appreciate as much as it could in order not to affect the export sector. Monetary authorities however continued as other Central Banks would have done to sterilize the upward pressure on the domestic economy like the imposition of various exchange measures.
The most difficult era for Malaysian policy makers has been since 1997 with the BNM having to adopt various monetary policy stands in order to adapt to the various financial and economic irregularities that has characterized this era. Firstly, was the Asian Regional crisis of 1997/1998. This period was characterized by extreme volatility in financial markets and it had wide ranging effects on the financial and economic activities. A major challenge to the BNM was balancing declining GDP and increased inflation rate. Additionally, the ringgit decline 40% in value to the US dollars. In response to this, the BNM adopted a fixed exchange policy of $1=RM3.80 on September 2008. Complementing this fixed exchange rate policy was reducing of interest rate and easing of monetary policy in order to support economic recovery. Together with other measures, these monetary policies proved very productive as the economy of Malaysia was able to weather the storm. Most key economic indicators began showing trends of recovery in 1999. Inflation which was 6.2 percent in June 1998(its peak during the crisis) was reduced to 2.3 percent and GDP growth was at 6 percent. The 2008/2009 Global Recession provided another shift in monetary policy implementation. As Alp, Elekdag and Lall (2012) observed, the global liquidity squeeze affected Malaysia and the downturn in global trade adversely affected exports from Malaysia with a 15 percent decline in export activities in the first quarter of 2008 alone. The BNM first monetary response was to safeguard short term funding in the financial system by announcing in October 2008 to support interbank lending. Also, in a bid to improve the dwindling export (which is a mainstay of the Malaysia economy), the BNM actively pursued some foreign exchange intervention notably, the depreciation of some exchange rate. It also cut interest rates to 2 percent. Alp, Elekdag and Lall (2012) study found out that without these bold monetary policy adjustments, the global finaicial crisis would have had a deeper contraction on the Malaysian economy. The main focus on monetary policy was discretionary interest rate cost with a very flexible exchange rate and this is well suited to the Malaysian economy because of its level of global economic integration.
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2.5 Trends of Monetary Policy Instruments to GDP Growth
Having chosen inflation, interest rate and money supply as the monetary policy variables, emphasis will now shift to comparing the trend of these variables with the dependent
variable. This will give a snapshot of how GDP growth has responded to the level of changes in various monetary policy instruments selected.
Figure 2.2: Trend of Inflation to GDP Growth
Source: Computed by Researcher using Data from World Bank
The figure above shows the trend of in the GDP growth rate and inflation. As can observe from Figure 3.1 above, in 1986, GDP growth and inflation in Malaysia moved in opposite directions; inflation dropped but there was a minimal increase in GDP growth that year. However, from 1987 to 1998, GDP growth and inflation in Malaysia moved in tandem (in the same direction). After 1998, both GDP growth and inflation continued to show similar trends over the years.
Another important observation from this graph is that GPD growth rate was only negative at two different periods 1998 and 2009 which were periods of financial distress in the Asian region and globally respectively.
-10 -5 0 5 10 15 1984 1989 1994 1999 2004 2009 2014 GDP GROWTH INFLATION
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Figure 2.3: Trend of Interest Rate to GDP Growth
Source: Computed by Researcher using Data from World Bank
The graph above shows the trend of interest rate to GDP growth rate. The trends are very dynamic. While it can be observed that are some points, interest rate and GDP growth rate exhibited similar trends, the general movement of the variations shows a lot of movement in different directions. It can however be observed that in 2009 during the Global economic crisis, the monetary authorities as a response increased the interest rate to 11.78 which is the highest in the period under review. This was clearly an expansionary monetary policy aimed at boosting the economy in the depressed economic state. It can also be observed that when the economy began to grow, the interest rate was shifted to 0.8 in 2010.
-10 -5 0 5 10 15 1984 1989 1994 1999 2004 2009 2014
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Figure 2.4: Trend of Money Supply on GDP Growth
Source: Computed by Researcher using Data from World Bank
The graph above shows the trend of money supply growth and the GDP growth of Malaysia. One can observe money supply have possessed a positive trend over the years except for 1990. According to Ahim et al. (2014), in 1990, the Malaysian authorities introduced the New Development Policy (NDP) which replaced the New Economic Policy (NEP) and the implementation of this policy initially brought about some economic and financial crises as the government aimed to include more native people in the industrial sector of the country. However, the gains of the new policy began to roll in almost immediately as can be observed from the 71.91 increase in money supply the following year.
In general, both trends move in the same direction and even show the same proportionality except in 2011. -60 -40 -20 0 20 40 60 80 1984 1989 1994 1999 2004 2009 2014
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CHAPTER THREE 3 LITERATURE REVIEW 3.1 Introduction
The actualization of macroeconomic goals and objectives which are to wit; stable growth of Gross National Product (GNP), stable level of prices, high employment levels and stable (equal) balance of payments have from introspection been a policy precedence of every country (whether developed or developing). Delic and Kraguli (2005) reveal that in order to attain these goals, several macroeconomic instruments are used and that these instruments are fiscal policy, monetary policy, income and price policies and international economic policy. Sanni et. al (2012) however opined that the two basic policy instruments are fiscal policy and monetary policy in achieving all aforementioned objectives. This chapter will focus on works that have been done by past researchers and various academicians in this field.
This chapter will be divided thus: 1. Conceptual review
2. Theoretical literature
3. Review of empirical findings 4. Summary of empirical literature
3.2 Conceptual Review on Monetary Policy and Economic Growth
Milton (1969), regarded in many quarters as the father of monetarism gives the definition of monetary policy as the decisions carried out by monetary authorities and institutions often the Central Banks to affect and influence monetary and financial activities through exercising control over the availability and pricing of credit in pursuit of the broader aims of maintaining growth of output, price stability and healthy balance of payments positions. The discretional adjustment of money stock in his opinion involves the shrinking or expansion of money and influencing interest rate (which is viewed as the opportunity cost of holding money) to make money economical or more costlier depending on the current economic realities of the economy and the objective that the authorities wishes to achieve.
According to Rasche and Williams (2007), monetary policy can be defined as central bank actions to influence and/or target short term interest rate or nominal exchange rates.
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According to them, this was a different definition to the predominant definition during the “monetarist revolution” of the 1960s and 1970s which was focused on “high-powered money”-liabilities of the central banks.
Akrani (2010) after examining definitions of Prof. Harry Johnson and A. G. Hart who respectively defined monetary policy as “a policy involving the central banks control of the supply on money as an means of actualizing the objective of general economic policy…” and “A policy which manipulates the general stock of money substitute of public demand for such assets of both that is policy which affects public liquidity position…” opined that monetary policy is related to the availability and cost of money supply in the economy in a view to attain certain broad objectives.
In order to fully understand the proper functioning of monetary policy, it is important to x-ray the instruments a central bank is able to use and how these instruments would have effects on the price determination.
Horngren (2005) points out that the ways in which central banks measures impinge the economy and price levels is known as Monetary Transmission Mechanism (MTM). He further explains that the general premise is that transmission mechanism is carried out through two channels; one is interest rate targeting, the practice in many industrialized countries and that the other channel is through aggregate demand and that if growth of demand exceeded expansion of production capacity inflationary pressures will grow.
Ireland (2006) agreed with the views of Horngren and but pointed out more monetary transmission channels like asset price channel (in this case, stock price falls after a monetary tightening, household financial wealth declines leading to a fall in output, consumption and employment). He also identified the credit channel which is further divided into two; the bank lending channel and the balance sheet channel.
Rummel (2012), identified with the aforementioned channels. He also drew attention to the exchange rate channel which is totally dependent on the manipulation of the interest rate and the effect all such manipulations have on the net exports, import prices and the net wealth.
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Figure 3.1: The Transmission Mechanism of Monetary Policy
Source: The Monetary Policy Committee: Bank of England
3.2.1 Economic growth
Economic growth is very important. Overall, the main objective of any economy is to attain economic development. Generally speaking, it is a major macroeconomic objective which every government and monetary policy institution strive to achieve usually by setting well thought out plans and steps towards achieving such plans. There is however no full proof or generally accepted indicator for measuring economic growth. The general consensus is the use of growth in GDP or Gross National Income (GNI) but more recently, there are also other indicators which has been adopted to measure economic growth such as the stock of capital, level of employment or employment rate, investment levels, aggregate savings, consumption volume, level of government spending and as such just increase in GDP/GNI proves insufficient.
Shearer (1961) opined that the term “economic growth” generally carries a meaning of increase in terms of numbers but mentioned that there still exist widespread disparities amongst scholars as to the magnitude which is in fact the relevant measure of economic growth. Moving forward, he stressed out that the main unifying element in this “quantitative” definition is that what should ideally be measured is the contribution of economic activity to the achievement of higher state of human welfare.
Haller (2012) defined “economic growth” in a specific way increment in national income per capita and it involves the analysis, particularly in quantitative terms, of this process with a
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focus on the functional between the endogenous variables. He also extended the definition to an increase of GDP, GNP and NI. In summary, economic growth is the process of increasing the sizes of national economies, the macro-economic indications with positive effects on the socio-economic sector.
3.2.2 Objectives of Monetary Policy
Cecchetti (2000) identified the following as the objectives of monetary policy
Price Stability
Output Stability
Interest rate Stability
He however argued against the inclusion of exchange rate targeting which he viewed as analogous to monetary-aggregate target; a means to an end and not an end in itself. McCauley (2006) however identified exchange rate targeting as a policy objective in Malaysia. This is often the case in many other developing countries which tries vigorously to better their balance of payment position.
3.2.2.1 Price Stability
This is considered in many quarters as the most important policy objective of monetary policy. It is the popular and current approach applied by Central Banks around the world. Central banks generally view the cost of inflation as very high and try to normalize inflation at a level that is low enough that it becomes insignificant to household and firms.
Gerdesmeier (2015) pointed out that in achieving this policy strategy, there are five elements involved.
The public announcement of numerical targets for inflation usually set up periodically, annually or quarterly depending on the country.
Institutional committal to price stability and other goals under the price stability umbrella by government and/or monetary authorities
An information-inclusive strategy in which other variables, not only monetary aggregates or exchange rates but even fiscal policies are used for deciding the selling of policy instruments
Transparent money policy that shows the role of informing the public of markets plans, objectives and rationale for decisions of the central banks. This way, one and all is aware
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of what the authorities are trying to achieve and put in their own effort towards achieving this
Finally, mechanism that makes the central banks accountable for attaining its inflation objectives. A score card of some sort, where the performance in comparison to the goals is measured.
3.2.2.2 Output Stability
This is consequential of the price stability objective. Cecchetti (2000) however stressed that the inclusion of output stabilization in central bank monetary objective is very pertinent but that the problem arises as to how much importance should be attached to it relative to price stability. Mishkin (2002) however examined the role of output stabilization in the economy and concluded that monetary policy makers trying to focus on strictly on output stability in formulating policies is likely to produce worsened outcome for output and inflation because it makes monetary authorities’ communication’s strategy more difficult and can enfeeble the credibility of the Central Bank.
3.2.2.3 Interest Rate Stability
The Central bank takes it as a very important objective to smoothen and regulate interest rate. This is built on the knowledge that smooth interest rate is very important to the proper functioning of the financial system and there is no economy which can basically function proper well with a weak or terrible financial system. Another argument for the need for a smooth interest rate is that it strengthens and emboldens the credibility of the Central Bank. Large movements and fluctuations in interest weaken the belief in the financial system especially if there is no proper explanation for such fluctuations.
3.2.2.4 Exchange Rate Stability
Exchange rate stability is mainly indigenous to developing countries. McCauley (2006) pointed out that this objective can however come in conflict with inflation stability as exchange rate directly transfers inflationary or deflationary foreign prices. Filardo et. al (2011) however pointed out two broad motive for exchange rate stability: concerns for short term impact on macroeconomic and financial stability and concerns on middle to long term impact on resource allocation.
3.3 Theoretical Review of literatures
Just as many other economic concepts alike, various schools of thought have contributed to
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affecting the developmental stride in countries have been discussed since the classical economic theory and it has undergone various diversified and complex evolution since the ages. This section is devoted to various economic theories while focusing on monetary theory with an eye on its effectiveness and policy implication without a lengthy explanation in details of the theories themselves.
3.3.1 Quantity Theory of Money (QTM)
This is possibly the oldest surviving economic theories. This theory in its simplest form states that variations in the general level of commodity prices are determined primarily by variations in the quantity of money in circulation. This dates back to the mid-16th century but has undergone several refinement, amendment but came to prominence in the next 2 centuries owing this prominence to work by John Locke, David Hume, Richard Cantillion and this theory was integrated into orthodox monetary tradition; it also formed the underpin of the classical monetary theory
In brief, the QTM postulate that the stock of money (M) is the main determinant of the price level (P). QTM contend that aggregate price (P) and total money supply are related in this equation
Where V = velocity of money
Y= Real Output
Expressed in percentage change (growth rates), the QTM becomes
Where p is rate of inflation;
y, v & m represent growth ratio of output, velocity and money stock respectively.
This suggests that a given change in the rate of money growth will result in an equal growth in growth in the inflation rate. This led to the famous claim of Milton Friedman that “inflation is always and everywhere a monetary phenomenon”. The essential assumption behind this claim is that the velocity of money (V) or its growth rate is constant and that the rate of money growth has no effect on real GDP-or at least not significantly in the long run.
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However, further analysis showed that the long run interactions between inflation and money growth are not always affected by monetary issues.
Fisher’s equation of exchange:
Where M is the money supply,
V represents the velocity of circulation, P represent the price level and
T represents physical volume of market transaction. Cambridge cash balance equation:
M is the stock of money in circulation;
K represents the desired cash balance ratio in other words the ratio of nominal money supply to nominal income.
P represents the price level of national income and y is the real national income.
Humphrey (1974) explained that the policy implication of monetary policy is clear. Monetary policy could exert a powerful and anticipated influence on the price level. With velocity, V and transactions T assumed as constant, Fisher’s equation in a nutshell states that a policy-with a percentage change in money stock would results in the exact same percentage change in the price level.
3.3.2 Modern Monetarist Method
The modern monetarist approach is the reinvigoration and renewal of the tenets of the quantity theory in contemporary times. Humphrey (1974) however posits that despite the many sophisticated and complexity in attempts to adjust the theory, there has been no significant change in its paradigm since the early 19th century. So while the chief conclusions of the classical theory are the ineffectiveness of money in the long-run equilibrium, brief non-neutrality of money in developing period, casual or non-effective role of money in
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transmission mechanism, the monetary theory of price movements, Long run equality between money and price and exogenous nature of the money supply.
Proponents of this school still contend that the long-term expansion path of output is caused by real factors for example resource allocation, technology and the productiveness of factors of production (labor and capital). It is also argued that the changes in the money stock can have no long-run on the real determinants of output. Monetarists however agreed with the classical belief that the real rate of interest is explained by factors that are not monetary i.e. productivity and thrift. Monetarist also follow the classical position of short-run non-effectiveness of money which means that a swift movement in the supply of money or its growth rate will have an infinitesimal effect on output, employment and the product mix. Monetarists posit that price cannot adapt instantaneously to sudden monetary change because it takes a while for people to understand and adapt to any of such sudden monetary change. The principal role of money is also propounded by the monetarists in their theoretical underpinning of the monetary adjustment process. Here, the monetarists view is that the driving force is a surplus of money supply; if domestic consumers have more money than they require, they spend the surplus for assets, consumption and investment goods. Thus increasing spending which translate to higher prices.
On monetary transmission, the monetarist emphasized more, the role of interest rate than did the classicalists. There is also an agreement on the exogenous nature of money supply between modern and classical monetarist.
3.3.3 Neo-Classical Growth Theory
The neo-classical growth theory places emphasis on capital accumulation and the decision to save as a very important determinant for economic growth. In the neo-classical growth theory parlance, the Solow growth model is usually the focal point of reference. In the Solow model, long run growth of output per capital depends only on technological progress. However, short run growth can come about due to technological progress or capital accumulation. Solow (1956) adopts a direct expression on the constituents of the economic growth based on the equation below:
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Where Y represents Output, L represent labor, K represent capital and the term R(t) is called the “Solow residuals”. All exponents in the equation above represent growth rates of the variable. The above equation indicates the transmission mechanism in which the variables can impact economic growth of a country. It is clear from the above that growth under the Solow model is a function of growth of capital, labor and the Solow residuals. The Solow residuals are also referred to as Total Factor Productivity (TFP) which is regarded as the index of technological progress.
Although the equation shows how the variables affect economic growth, it did not essentially point out the way monetary policy affect economic growth. Mundell (1963) however put forward a comprehensible mechanism linking inflation and output growth differently from too much demand of commodities. Mundell’s model shows that a rise in inflation or inflation mechanism will cause people’s wealth to dwindle. This is owes to the fact that the return rate on individual’s real money balance falls. And as such, in order to accumulate the desired wealth, people will save more by switching their assets, increasing their price and thus driving interest rate down. Conclusively, in Mundell’s view, more savings equals greater capital accumulation and thus faster output growth.
Tobin (1965) improvement on the Mundell’s model is that individuals would switch present consumption for consumption in the future by either holding money or acquiring capital. The Tobin effect in other words, maintains that inflation causes individuals to substitute money for interest earning assets, which leads to increased capital accumulation and fosters economic growth.
3.3.4 Endogenous Growth Model
Also known as new growth theory, the endogenous growth model extend the classical theory by making rate of technological progress or the rate of population growth as both endogenous. In the monetary framework of the endogenous growth model as developed by Lucas (1988) and Greiner (2013), the rate of inflation lowers both the return on capital and economic growth. Nevertheless, some representations of the endogenous growth model revealed that inflation rate effects are insignificant.
3.4 Empirical Reviews of Literature
There is a rich stock of empirical literatures that shows the works of various scholars who at various times have carried out studies on the relationship between economic growth and monetary policy ranging from studies in developed countries to that in developing countries.
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It is however evident from all these studies that there is no unique result. The effect of monetary policy varies based on the economic activities and stability of the country in focus. As an example; Hussain, Wijeweera and Hoang in their research explored the connection between macroeconomic variables; money supply, fiscal, real exchange rate, interest rate and output in view of small open Association of South Eastern Asian Nations countries using the Johansen’s multivariate con-integration analysis. They also employed the Vector Error Correction Model, Granger Causality and exogenity test in checking out the Long and short run relationship, the causality etc. between these macroeconomic variables. The result of their research implied that there were stable long term interactions amongst all the variables in all the chosen ASEAN countries. Also, a one-way causality between money supply and aggregate demand (or real output) for Malaysia. There was no however nonexistence of a short run causality between aggregate demand and government spending in any country. Chaudhry, et al. (2012) surveyed the existence of long run interconnection and correlation between monetary policy, economic growth and inflation in their research by employing the co-integration and causality analysis using the country of Pakistan as their sample case. The result in their research showed that credit to private sector (the variable for financial depth), real exchange rate and budget deficit are significant variables that influence the real GDP of Pakistan. The Pair-wise Causality result suggested that real GDP and exchange rate are causing each other bi-directionally.
Nibeza and Tumusherure (2015) in their own research, using annual series data for the period of 1980-2006 and Vector Error Correction Models analyzed how money supply (M2), Exchange rate affect the Gross Domestic Product in Rwanda. The test revealed a significant effect of monetary policy (money supply and exchange rate) on GDP. The conclusion of their findings indicated that monetary policy had a predominant influence in maintaining price stability and controlling inflation in the economy of Rwanda.
Kamaan (2014) quantitatively measured the impact monetary policy have on the economic growth in Kenya and the findings indicated that a standard deviation monetary policy shock of the Central Bank of Kenya has a positive and significant relationship with growth. The findings indicated that monetary policy will influence and ensure economic growth.
Sulaiman and Migro (2014) in their study evaluated the nexus between economic growth and monetary policy. The policy instruments they selected were Cash Reserve Ratio, exchange rate, money supply and interest rate with the time lag being 1981-2012 using co-integration
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test in Nigeria. The result indicated that monetary policy has a noticeable influence on the growth of the economy. The test for causality indicated that the monetary transmission mechanism has positively affected the production level of the economy.
Kasidi and Nwakanemela (2013) used time series data for 1900-2011, Co-integration co-efficient and co-integration technique to measure the relationship between inflation and GDP in Tanzania. The coefficient of elasticity was used to measure the responsiveness of changes in GDP to changes in general price level. The result of their analysis was that inflation has a negative impact on economic growth. It also found that there was no long run relationship between inflation and economic growth in Tanzania.
Gul, Mughai and Rahim (2012) in their research applied the Least Squares (OLS) estimation model and reviewed how the decisions of monetary authorities influence macroeconomic variable. Making GDP as the dependent variable, the result of the result was that tighten monetary policy in in relation to the adjustments of money supply, exchange rate policy and increase in price level (inflation) which serves as the independent variables shows a positive relationship with dependent variable. In other words, there was a positive relationship between monetary policy and economic growth.
In examining the impact of monetary policy on economic growth in Pakistan Ullah (2013) persecuted his research using time series data from 1991-2001 of the country. Exploring each endogenous variable using Error Correction Model (ECM), findings indicted that there existed a long run relationship between monetary policy and economic growth. The study also came to the conclusion that the monetary policy instruments selected for the study (inflation rate, exchange rate and external reserve) were significant instruments that controlled the economy.
Hameed and Ume-Amen (2011) in their research focused on the impact of monetary policy n GDP using regression analysis and time series data of 30 years in Pakistan. The findings of their study were that interest rate exhibited a minor relationship with GDP but that money supply greatly affected GDP.
Alavinasab (2016), empirically measured the impact of monetary policy on economic growth in Iran over the period of 1971-2011 using regression analysis. The finding of the study was that there is a long run significant influence on economic growth by money supply, exchange
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rate and inflation. Using Estimated Error correlation Model, it reveal that money supply and exchange rate significantly impact economic growth in Iran.
Soufran (2013) examined the casual relationship between GDP and money supply in Jordan using the Granger Causality method in order to determine the direction of the relationship between both variables. The result is that there is casual relationship between money supply to GDP and not vice versa.
Chipote and Makhetha-kosi (2014) explored the role played by monetary policy in promoting economic growth in South African economy. They first of all employed the Augmented Dickey-Fuller and Phillip Peron Unit test to check for the stationarity of the series. Thereafter, the Johansen co-integration and the Error Correction Mechanism were employed to test for the short and long run relationship between the variables. The empirical conclusion of this study indicated that the monetary instruments selected (exchange rate, money supply repo rate otherwise known as interest rate) are insignificant monetary policy instruments that control the economic growth in South Africa.
Amarasekara,(2009) utilizing the Vector Autoregressive (VAR) framework and both recursive and structural specification analyzed the effect of interest rate, money supply, and movement in nominal exchange rate on real GDP and inflation in Sri-Lanka from 1978-2005. The result of the findings when interest rate is considered the monetary policy variable were fully in accordance with empirical findings but when money supply was the monetary policy instruments, result contradicted empirical findings. Interest rate innovations were found to be persistent while money growth and exchange rate were not. It supported the researcher’s opinion that monetary authorities adjusted interest rate gradually and consistently.
Ogunmuyiwa and Ekone (2010) empirically evalauted the impact of money supply can exert on the economic growth using GDP and GDP growth rate as the indicator of economic growth and annual series data between 1980 and 2006. They used the Ordinary Least Squares, Causality Test and ECM test. The findings of their research was that money supply exert positive effect to GDP growth but it was however insignificant to GDP growth rate in Nigeria economy; Nouri and Samimi (2011), also carried out a similar study using the same Ordinary Least Squares (OLS) and annual data from 1974 to 2008 in Iran and employing the Levine and Renelt growth model. The conclusion revealed that the existence of a positively significant relationship between money supply and economic growth in the Iranian economy.
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There have also been studies that have measured the impact of monetary policy and economic growth in Malaysia.
Munir, Mansur and Furuoka (2009) empirically investigated the presence of threshold effect in the nexus between inflation and GDP growth rate in the context of Malaysia with new endogenous threshold autoregressive (TAR) models with annual time series data from 1970-2005. The conclusive finding of the study revealed that there is a statistically significant positive relationship amongst inflation and growth of the economy.
Kogid, Asid, Lily and Mulak (2014) investigated the effect of exchange rates on economic performance in terms of growth using time series from 1971-2009. The conclusion or findings of the ARDL bound test is that a long run con-integration exists between nominal and real exchange rates and economic growth. Also, a significant positive coefficient was recorded for real exchange rate. In addition, results of ECM-based ARDL reveal that both exchange rates have a causal effect towards economic growth.
Ibrahim (2005) measured the effects of monetary policy using VAR models in accordance with many already existing studies in Malaysia. The results proven supportive and lent credence to the real effects of monetary policy shocks and found in response to positive interest shocks, manufacturing, construction, finance, insurance, real estates and business service sectors seem to decline more than aggregate production. The results seem to confirm potential disparities and dissimilarities in the effect of monetary policy on the real sectoral activities.
Poon (2010) examined various transmission mechanisms in economic growth in Malaysia over the quarterly period 1980Q1-20o4Q4 using bound testing approach. The study showed evidence of co-integration between real Gross Domestic Product and the real rate ofexchange and share prices is the key transmission mechanism in the conduct of monetary policy in Malaysia.
Kin et. al (2014) studied the relationship between monetary policy and GDP in Malaysia using quarterly data from 1991Q1-2001Q1. Their study utilized various estimation techniques such as the Unit root stationarity test, Johansen Cointegration estimation analysis and vector error correction method (VECM) were applied in the study. Result was suggestive that there is existence of a long run steady and balanced relationship between GDP, M1 narrow definition of money, M2 , M3 and real interest rate; M1, M2, M3 are statistically
